What is cost of living adjustment (COLA)? And how it works

As inflation impacts purchasing power—with the PCE price index, a key inflation measure, having increased 2.6 percent year-over-year—and talent competition intensifies globally, companies need to understand how a cost-of-living adjustment (COLA) works for smart compensation decisions. Getting COLA right can mean the difference between retaining top talent and losing them to competitors.

This guide explains what cost-of-living adjustments are, how they benefit your organization, and practical implementation approaches—especially for global teams.

What is a cost-of-living adjustment?

A cost-of-living adjustment (COLA) is a salary or benefit increase that helps employees maintain their purchasing power when inflation raises the cost of goods and services. When prices go up but salaries stay the same, workers essentially get a pay cut in real terms.

COLA compensates for this by adjusting compensation upward, typically based on economic indicators like the Consumer Price Index (CPI), which represents the expenses for over 90 percent of the U.S. population. Companies aren't legally required to offer COLA, but many use it as a retention and fairness tool.

Why is a cost-of-living adjustment important?

Companies trying to decide whether to provide COLA must weigh the benefits and costs of doing so. The clear cost of offering these benefits is the financial outlay required. Providing cost-of-living adjustments means paying employees more and having less money to spend in other areas.

However, the following benefits of providing cost-of-living adjustments may offset this financial strain:

• Increased employee loyalty: Holding on to great employees can be challenging, and with wage growth reportedly normalizing toward those rates seen pre-pandemic, offering benefits like cost-of-living adjustments can inspire greater company loyalty and make employees more likely to stick around.

• Better morale: Employers who offer cost-of-living adjustments show employees that they care about their concerns and livelihoods. This will boost morale around the company.

• Greater productivity: COLA alleviates some financial stress and strain for employees, making them better able to focus on their work. Output and productivity will also likely increase for workers who receive these pay increases.

All these benefits help contribute to the success of the company. Employers must decide for themselves whether the benefits of giving these pay increases are strong enough to outweigh the costs.

How is the cost-of-living adjustment determined?

Companies have flexibility in how they calculate COLA since there's no legal requirement to offer it. Common approaches include:

• Consumer Price Index (CPI): Tracks inflation in goods and services by recording the prices of about 80,000 items each month to measure consumer price changes.

• Local inflation rates: Region-specific cost increases

• Market benchmarking: What competitors are offering

• Company performance: Tied to business results and budget

The amount and frequency can vary—some companies adjust annually, others as needed based on economic conditions.

Do companies have to offer cost-of-living adjustments?

Unless it's required by law, it's generally up to each company to decide whether to offer this benefit and, if so, how much to provide as a cost-of-living adjustment.

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COLA adoption has shifted dramatically over the past decade:

• 2010: Only 10% of U.S. employers provided cost-of-living adjustments

• 2023: 80% of employers planned base pay increases due to inflation

This shift reflects the tight labor market and rising inflation pressures that have made COLA a competitive necessity for many organizations.

Note that a cost-of-living salary adjustment does not go to a single employee or just a group. For it to be a true cost-of-living adjustment, the employer must offer this raise to every employee—not just a select few. COLA is not merit-based or related to employee performance.

Managing COLA for global teams

Applying a cost-of-living adjustment gets more complex when your team is distributed across different countries. A flat percentage increase might not be fair, as inflation rates and living costs vary significantly from one location to another. Federal Reserve data illustrates this variance, showing that the cross-industry standard deviation of hourly earnings more than doubled in the years following the pandemic. For example, a 3% raise in a country with 8% inflation feels very different from the same raise in a country with 2% inflation.

Global employers need a strategy that balances fairness with local market realities. This often means using localized data to inform adjustments, ensuring your compensation remains competitive everywhere. A global employment platform can provide the salary insights and tools needed to manage these complexities, helping you make equitable decisions for your entire team.

This approach not only helps with retention but also shows your commitment to caring for your people, no matter where they live. With the right partner, you can build a fair and competitive compensation strategy that supports your team everywhere. To see how Oyster can help you navigate global compensation and start hiring globally, get in touch with our team.